Monday

 

Mostly summarized from Gregory Mankiw’s Principles of Economics, 5th Ed.

PART 8 The Data of Macroeconomics

Chapter 23 of 36 Measuring A Nation’s Income

Section 3 of 15

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Figure 1 - The Circular-Flow Diagram

Households buy goods and services from firms.

Firms use their revenue from sales to pay wages to workers, rent to landowners, and profit to firm owners.

GDP equals both

· the total amount spent by households in the market buying goods and services

· the total wages, rent, and profit paid by firms in the markets for the factors of production

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Starting with households, following yellow line inner circle and moving clockwise:

1-households sell labor, land, and capital in the markets for factors of production to firms

2-firms use the factors to create goods and services

3-firms sell goods in the markets for goods and services to households

4-households consume the goods and services

Starting with households, following green line outer circle and moving counter-clockwise:

A-households’ spending on firms’ goods and services creates equal amount firms’ revenue, A equals GDP

B-firms’ payment of wages, rent and profit creates equal amount households’ income, B also equals GDP

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To judge the economic situation of a person, you could look at their income.

With a high income a person can more easily attain a high standard of living.

People with higher incomes have higher standards of living including more and better housing, cars, healthcare, and vacations.

We can similarly look at a nation's overall economy.

When judging whether the economy is doing well or poorly, we first look at the total income earned by everyone.

Total economy income is measured by gross domestic product (GDP).

GDP measures two things: income and spending, which are:

· total income of everyone in the economy

· total spending on all the economy's produced good and services

In a country with high income (GDP) the people can more easily attain a high standard of living.

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An economy's income must equal its spending because every transaction has two parties, a buyer and a seller.

Every dollar of spending by a buyer is a dollar of income for a seller.

Suppose Karen pays Doug $100 to mow her lawn

Doug is a seller, and Karen is a buyer.

Doug earns $100, and Karen spends $100.

This transaction contributes equally to the economy's income and its spending.

GDP, measured either as total income or total spending, rises by $100

The Circular flow diagram Figure 1 describes the total of transactions between households and firms and explains the equality of income and spending.

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circular flow diagram

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